Financial Reporting and Analysis
0REVIEWING THE CHAPTER
Objective 1: Describe the objectives and qualitative characteristics of financial reporting
and the ethical responsibilities that financial reporting involves.
Financial reporting should fulfill three objectives. It should (a) furnish information that is
useful in making investment and credit decisions; (b) provide information that is useful in
assessing cash flow prospects; and (c) provide information about business resources, claims
to those resources, and changes in them. General-purpose external financial statements are
the main way of presenting financial information to interested parties. They consist of the
balance sheet, income statement, statement of owner’s equity, and statement of cash flows.
Accounting attempts to provide decision makers with information that displays certain
is the qualitative characteristic of information that enables users to
perceive its meaning. To understand accounting information, users must be familiar
or rules of thumb (discussed in paragraph 4 below),
used in preparing financial statements.
Another very important standard is
To be useful, information must be
relevant and reliable.
means that the information is capable of influencing a
decision. Relevant information provides feedback, helps in making predictions, and is
means that the information accurately reflects what it is meant to
reflect, that it is credible, verifiable, and neutral.
Users of financial statements depend on a company’s management and accountants to act
ethically and with good judgment in preparing the statements. One product of the Sarbanes-
Oxley Act is that the chief executive officers and chief financial officers of all publicly
traded companies are required to certify that, to their knowledge, the quarterly and annual
statements filed with the SEC are accurate and complete. Persons found guilty of fraudulent
financial reporting are subject to criminal penalties and fines.
Objective 2: Define and describe the conventions of
materiality, conservatism, full disclosure,
To help users interpret financial information, accountants depend on five conventions:
comparability and consistency, materiality, conservatism, full disclosure, and cost-benefit.0
means that the information allows the decision maker to compare the
same company over two or more accounting periods or different companies over the
same accounting period.
means that a particular accounting procedure,
once adopted, should not be changed unless management decides it is no longer
appropriate or unless reporting requirements change. The nature of the change, its
justification, and its dollar effect on income should be disclosed in the notes to the